Rising with the vapors: Companies take in revenue as e-inhalers gain in popularity

Nunica, Mich.-based Victory Electronic Cigarettes has grown through acquisition and now plans to raise $149.5 million in a public sale of stock.

Chances are good that by this time next year you will have firsthand contact with someone who vapes — uses an electronic inhaler that simulates the act of smoking.

And when you observe the thick cloud of vapor emanating from that person's mouth instead of smoke, you may be witnessing the biggest single play in consumable products that some industry executives say is a once-in-a-lifetime opportunity.

"In my career, there has not been a sector that has so much potential and is so untapped in terms of value and global reach," said Jim McCormick, CFO of Victory Electronic Cigarettes Corp. (OTCQB: ECIG), a West Michigan company that aims to be the nation's largest independent producer of vaping products.

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Retail sales of e-cigarettes reached about $3.5 billion worldwide last year — barely a puff of the total $756 billion market still dominated by tobacco.

Daniel Lawitzke, a Grand Rapids entrepreneur who pioneered the retail market in vaping liquids and devices in West Michigan, likens it to the rush to the marketplace by dietary supplements in the 1990s, when "antioxidants" became a household word — followed by the need for the U.S. Food and Drug Administration to step in with regulations.

Instead of smoking "analog" cigarettes that contain hundreds of chemicals resulting from the combustion of tobacco, people are inhaling a vapor of vegetable glycerin and propylene glycol, flavorings and nicotine. To produce the vapor as they inhale, users activate a device that generally has a battery-powered heating element surrounding a wick saturated with the e-liquid.

Lawitzke, who launched Mister-E-Liquid LLC in the summer of 2010 after he was able to quit smoking through vaping, now employs 43 full- and part-time people at a 16,000-square-foot laboratory and two retail outlets in Grand Rapids, with plans to open a third store in Lansing this month.

Brick-and-mortar outlets such as Lawitzke's that are springing up throughout Michigan are only a wisp of the industry's vapor cloud. More than a thousand businesses worldwide hope to strike it rich as suppliers to people who vape, ranging from gargantuan corporations such as Altria Group Inc. and Lorillard Inc. to tiny operations with whimsical names such as Planet of the Vapes that sell e-liquids online. Some mom-and-pop operations literally whip up their e-liquid formulas in kitchens, garages and basements.

Wild Bill's Tobacco, a Clawson-based owner of 21 tobacco specialty stores and franchiser or business partner in an additional 29 such stores throughout Michigan, is shifting gears to capture market share in vaping. The company, founded in 1994 as the Smoker's Outlet, has launched two stores called Mr. Vapor that cater specifically to the vaping consumer, said Wild Bill's chief marketing officer, Justin Samona.

Over the next year, Wild Bill's hopes to open 10 additional Mr. Vapor stores, mostly in the Detroit area. In addition, all Wild Bill's stores now have Mr. Vapor sections, which offer a variety of products and "gourmet juice bars" that allow store personnel to mix customized e-liquid blends for customers.

"Every day, customers are switching over from tobacco cigarettes to electronic cigarettes because they see it as a healthier alternative — also a cheaper and cleaner alternative," Samona said. "Instead of having to go outside to smoke a cigarette — especially when it is cold — it is something they can do inside their homes and maybe even their workplaces."

Justin Samona

One website lists more than 180 retail outlets in metro Detroit as selling vaping products.

Samona said his company is slowing down expansion of the Wild Bill's concept and focusing more on Mr. Vapor, a move that also serves to protect existing Wild Bill's locations from losing customers to other vape shops. A Mr. Vapor shop may carry three times the selection of e-cigarettes, disposables, starter kits and e-liquids that a Wild Bill's carries, he said.

The company employs about 120 people throughout its chain of stores and at its 15,000-square-foot distribution center in Clawson.

Other companies such as LorAnn Oils Inc. in Lansing are being swept up unintentionally by the vaping revolution. LorAnn, established in 1962, is an old-line manufacturer and distributor of flavorings and essential oils used by home crafters and professionals who make candy, baked goods, frozen desserts and soaps. But several vaping websites recommend LorAnn Oils flavorings for e-liquids, even offering a color-coded list of those best for inhalation.

"We are in a bit of a quandary," said John Grettenberger Jr., grandson of LorAnn Oils founder O.K. Grettenberger. "Our flavoring products are FDA-approved for ingestion, and no one knows the result of them being used for inhalation. We would never suggest that our products be used this way, and we wouldn't even think about going after this market."

Speed is of the essence

JON BROUWER

Brent Willis, president of Victory Electronic Cigarettes, has big ambitions — more than $200 million in revenue by year's end — for a company that currently operates out of space it shares with a woodworking business.

Victory Electronic Cigarettes has embarked on a go-big-or-go-home strategy that its president, Brent Willis, likens to a military campaign. The West Point graduate even invokes the name of the legendary war strategist Carl von Clausewitz when he talks about growing share in the vaping market.

"In his study of war, Clausewitz talked about the ability of maneuver — for us, that means speed, moving faster than the competition," Willis said. "You have to do the right thing — and you have to do the right thing at the right time."

Doing the right thing at the right time has placed Victory Electronic on a tear when it comes to acquiring other businesses. It has concluded three acquisitions of companies this year, and Willis said the company has agreed on terms to purchase seven more companies or distribution platforms in 2014 to further consolidate its sales and distribution channels.

Last month, Victory Electronic filed its federal S-1 registration for the public sale of stock to raise up to $149.5 million.

"So we have gone from zero in mid-2013 to about $75 million in revenues on a pro forma basis, and we expect to be well over $200 million in revenues by the end of this year," Willis said in an interview before the company filed its S-1 registration. Pro forma statements filed in the S-1 showed a net loss from operations of about $12.7 million.

The company intends to change its name to Electronic Cigarettes International Group Ltd. to match its ticker symbol, but the new moniker also reflects its worldwide sales strategy. Victory Electronic purchased Atlanta-based FIN Electronic Cigarette Corp. Inc. in February, United Kingdom-based Vapestick Holdings Ltd. in January and Must Have Limited in April.

Willis intends to put his international experience as a former executive for the Coca Cola Co., Kraft Foods Inc., Cott Corp. and InBev to work opening the international markets for Victory Electronic Cigarettes.

Big plans from a small space

To say that Victory Electronic is flying below the radar is an understatement: The company shares space with a woodworking business owned by Willis' father-in-law in rural Nunica, about 26 miles east of Grand Rapids. A towering grain elevator and parked semis of a nearby business overshadow the parking lot of Versatile Wood Solutions, a manufacturer of store displays and architectural millwork.

No sign marks the fact that Victory Electronic Cigarettes is operating in about 3,000 square feet at the plant.

"Every penny counts," Willis said with a grin when asked about the humble surroundings that serve as the nerve center for Victory Electronic. The company employs more than 100 people locally and at offices and distribution centers in Atlanta and the United Kingdom.

What is quickly thinning the crowd among vaping competitors is access to distribution through convenience stores and mass merchandisers such as Wal-Mart Stores Inc. and Rite Aid Corp., which serve a majority of the 1.3 billion people who the American Cancer Society estimates smoke worldwide.

"Retailers are already making (vaping) space for the big tobacco guys — Lorillard, Reynolds and Altria," Willis said. "But the big tobacco companies have some real weaknesses that we can exploit."

Brand, price and flavor selection aren't the biggest factors when it comes to consumers making purchasing decisions at this point, he said. "Right now, 65 percent of all brand choice today is made on what's there, what's available, what's on display," Willis said.

With the recent acquisitions, Victory Electronic sells its products through more than 50,000 retail outlets in the United States and Europe, which together make up an estimated 70 percent of e-cigarette sales worldwide, according to estimates from Euromonitor International, a London-based provider of global business intelligence.

Euromonitor estimated that retail sales of e-cigarettes reached about $3.5 billion worldwide last year, less than one-half percent of the total $756 billion retail tobacco market globally. Sales of e-cigarettes grew more than 180 percent in the United States in 2013 from the prior year, the firm said, and the sector is expected to continue to take more market share from combustible cigarettes.

Willis and McCormick hope to capture more shelf space by cutting lucrative deals with distributors and retailers that large tobacco companies will find hard to match. Tobacco companies typically offer distributors a 3 percent markup off of cost, while Victory Electronic Cigarettes can offer up to 25 percent markup off of cost, Willis said.

"That changes the economics for distributors in a very significant way," he said. "We offer 30-day payment terms to distributors, and the tobacco companies offer net minus five — you pay for your product on Monday and you receive it on Friday.

"We also offer very favorable profit margins for retailers like Meijer. The tobacco companies are at about 8 percent, while we can offer profit margins up to 50 percent."

In a study of 25 state laws that set minimum prices for cigarette wholesaling and retailing operations, the Centers for Disease Control and Prevention in Atlanta found in 2010 that the median wholesale markup was 4 percent and the median retail markup 8 percent.

With such high stakes, the world's largest tobacco companies have acquired or launched e-cigarette brands themselves. Since buying Blu Ecigs in 2012, Lorillard has built Blu into a leading e-cigarette brand with heavy promotion that tapped celebrity Jenny McCarthy.

Reynolds American Inc. launched its own Vuse brand in July last year, and Altria Group introduced its MarkTen brand in August.

Aside from elbowing for space on cigarette shelves, companies that make vaping products also are struggling to understand what their customers want. A bewildering array of delivery devices have flooded the market — such as — "cig-a-likes" that are the size and shape of ordinary cigarettes with rechargeable batteries, refillable atomizers about the size of a cigar and hundreds of formulas of e-liquids that are flavored to simulate blueberries, chocolate or even cotton candy.

"We don't know how the product is going to evolve — e-liquids, vaporizers, disposables, rechargeables," Willis said. "Anyone who says they know exactly where the market is headed is lying. So do it all. ... Take the best ideas and bring them to market very quickly."

For example, Victory Electronic is introducing at Walgreen Co. stores this month a disposable clearomiser system discovered in Europe that lets customers see the level of e-liquids left in the unit.

Lawitzke of Mister-E-Liquid has built a business on anticipating the market with a variety of ready-to-use, refillable and disposable delivery systems along with separate components such as batteries, coils and tips so customers can assemble their own personal vaping equipment.

More than half of Mister-E-Liquid's revenue comes from wholesale and retail sales of more than 100 flavors of custom-mixed e-liquids, which range from Gran-E's Apple Pie to Maniac Mint Chocolate. The company sells products in 47 countries and supplies liquids to more than 300 vape shops nationally.

Instead of competition, Lawitzke views companies such as Victory Electronic and Blu as portals for smokers-turned-vapers to find his business online.

"They think that people want a device that looks like a cigarette, but what we've learned is that people who are vaping really don't want to be associated with smokers," he said.

Soon after they try e-cigarettes, people often search out delivery devices that are higher-powered and refillable, Lawitzke said. "When they get them home and see $20 for a five-pack of cartridges, their first instinct is to say: 'I'm going to search Google and find them cheaper. And that's where we come in.' "

Another misconception is that adults don't like a variety of flavors. "The majority of our client base started with tobacco-flavored e-liquid, and they wanted it to taste like a cigarette when they first started," Lawitzke said. "What we found is after a month or so, our customers don't want to taste tobacco anymore — it's gross.

"After their taste buds regain their sense of taste, tobacco doesn't taste as good as strawberries or blueberries. The thing that gets people off analog cigarettes in the long term is the flavoring — the fact that you can taste apple pie if you want to taste apple pie."

Willis and Lawitzke were adamant about enforcing age restrictions on the sale of their products and the need for FDA regulations. In April, the federal agency proposed rules that would require vaping product companies to register, list ingredients in e-liquids and impose minimum age and identification restrictions to prevent sales to those under age 18. At the end of a 75-day public comment period, the agency will enact the rules that it deems necessary.

In the manufacture of e-liquids, "people are just picking up what looks good, and they are mixing it in their kitchens or, God forbid, their garages or bathrooms," Lawitzke said. "That's part of the problem. There's no accountability."

Mister-E-Liquid purchases its base materials, flavorings and nicotine from suppliers that document the concentrations and purity of their products and mixes the ingredients in its ISO-certified Class 6 clean room in Grand Rapids. The company, a founding member of the American E-Liquid Manufacturing Standards Association, does regular testing of final product, Lawitzke said.

Willis said Victory Electronic Cigarettes imports its products from China, but it has plans to move manufacturing to the United States during the next year.

"It's our intention to be the leading independent electronic cigarette company in the world, fully in control of our own destiny, right here in West Michigan," he said.

"Frankly, the thing that keeps me up at night is the money that big tobacco — and big pharma, for that matter — can throw around because we are eating into the smoking cessation business."